Here is a compilation of essays on ‘Risk Management in Banks’ for class 11 and 12. Find paragraphs, long and short essays on ‘Risk Management in Banks’ especially written for school and college students.
Essay on Risk Management in Banks
Essay Contents:
- Essay on the Scope of Financial Risk Management in Banks
- Essay on Risk Management Process in Banks
- Essay on Building Blocks of Risk Management in Banks
- Essay on Risk Management Structure in Banks
- Essay on NPA (Non Performing Assets) Management in Banks
- Essay on Risk Focused Audit in Banks
- Essay on Coverage and Approach of Risk Management in Banks
Essay # 1. Scope of Financial Risk Management in Banks:
Financial risk management is a planned exercise to deal with uncertainties in operations so as to mitigate and minimize the impact of risks. Looking for 100% safe method or alternatively avoidance of risk will not help an organization in the long run. The purpose of risk management is to identify the business activities and opportunities relevant to the organization objectives and manage the risks in those activities to take advantage of the opportunities.
Therefore, the logical steps are to identify risks, assess the probability of occurrence, measure the consequences, develop mitigation strategies, monitor and report the progress in risk reduction, make the decision to avoid, reduce, transfer or accept the risk.
The laws are made by the legislature, regulations are by the regulators who are appointed by the government, policies are decided by the Board of the organization and operational procedures including the compliance of laws and regulations by the top management.
Apart from rules and regulations, corporate governance, corporate ethics and moral standard also count in risk management. The operation process to exploit the opportunities and the relevant risk control measures are to be documented and circulated to staff. Business in good times can afford to take more risk and adopt dynamic style.
But in bad times it is better to be conservative and cautious. At the Board level creating a risk management committee is necessary which will oversee the alignment of risk exposure with business objectives and risk appetite. The operating staff should be well acquainted with organization objectives, procedures and possess necessary skill in risk identification, risk assessment, risk response, risk control, monitoring and reporting to the appropriate authority.
Risk appetite is the capacity to take risk in consonance with organization objectives. But the organization objectives are not simple and straight forward. They include business growth, market share, competition, profit etc. Growth in business, enlargement of area of operation and increase in number of products require realignment of risk. Therefore risk tolerance level need to be reviewed and monitored on continuous basis.
Risk management approach shall differentiate the activities where the organization possess core competency and those which fall outside core competency area and the approach should be appropriate to each situation. There are many reasons as to why the people in the organization take risk and thus create risk situations in business. It may be over-confidence, optimism, inertia, complacency, carelessness, excessive reward, ignorance or incompetence.
The risk report shall cover risk details, risk impact, pros and cons of counter measures to contain adverse effects of risk, prioritization in acceptance of risks, collection and submission of information to satisfy the regulators and rating agencies requirements.
Essay # 2. Risk Management Process in Banks:
In the circumstances:
(i) There should be risk management policies and procedure approved by the Board and all the operating staff in the organization should be well acquainted with relevant portions applicable to them and also familiar with overall approach in risk management,
(ii) There should be a disaster recovery plan and back up procedure in place to manage untoward situations,
(iii) Clear specification of duties and responsibilities of each individual and segregation of front office and back office duties more particularly in trading desks relating to securities and foreign currency and so also when there is conflict of interest in duties,
(iv) Guidelines and control system for taking positions in currencies and derivatives, Concentration of exposure to industry/group etc.,
(v) The internal and external audit should not only be on accuracy of transactions but also on the level of risk exposure,
(vi) The audit should focus on inadequacy of systems and procedure and also incompetency and shortage of staff and give suggestions,
(vii) Risk measurement should be based on a commonly accepted standard formula,
(viii) Determination of risk appetite level, tolerance level and risk reporting method are important components of risk management.
These efforts will help in understanding the nature of risks, trace the cause that trigger risks, quantification of risks and management of risks.
Essay # 3. Building Blocks of Risk Management in Banks:
Risk Study:
Will cover probability and consequences of risk.
Risk Assessment:
Risk Assessment will include identification, analysis and evaluation at organization level / department / project / product / activities levels.
Risk Analysis:
Involves identification of source of risk, and consequences of risk. The analysis may be quantitative or qualitative, while quantitative is on numerical basis, qualitative is generally impressionistic.
Probability Analysis:
It will be worked out based on historical data, forecast and expert opinion.
Risk Reduction:
The cost of risk reduction will require examination as to whether it is too high or normal so as to accept, reject or look for alternative. Risk reduction to zero level is normally impossible and hence it requires decision on optimum risk level. In arriving at the answers to the above questions errors in judgment are possible.
Errors are two types:
(1) Rejection of right opinion and views or
(2) Acceptance of false opinion and views Therefore issues demand careful consideration.
Risk Management Steps:
(i) Identify risk
(ii) Determine the risk pattern and level
(iii) Fix tolerance level
(iv) Measure risk
(v) Report on quantum of risk taken and risk control measures adopted both at pre and post risk situations
(vi) Arrangement to oversee the action process and risk impact
(vii) Risk audit
(viii) Fine-tune risk management process for better results and realign the risk with organization objective.
The outcome of these steps facilitate, designing right products, understanding customer’s need and customer relationship management.
Essay # 4. Risk Management Structure in Banks:
Risk management structure in banks was first mooted by the Basel committee which was accepted by RBI and issued guidelines to banks.
In order to achieve excellence in risk management, an independent Risk Governance Structure, in line with R.B.I, guidelines and international best practices, has to be put in place in every bank, with separation of duties ensuring independence of Risk Management, Monitoring and Control functions, from the business units at the operating level with technology as the key driver, enabling identification and management of risk at the place of origin.
Accordingly the Risk Governance Structure, Credit Risk, Market Risk, Operational Risk, Group Risk and Enterprise Risk Management Departments along with Basel Norms Implementation and Information Security Departments are to be placed under the chief risk management officer under the control of the Board to ensure integrated risk management in bank.
A. Credit Risk Management:
1. The bank shall have a strong credit appraisal and risk assessment practices in place. The bank can use various internal Credit Risk Assessment Models for assessing credit risk exposure under different segments. Internal ratings at the bank should be subject to comprehensive rating validation framework.
2. The department of credit risk management shall track industries including sectors such as Telecom, Power, Coal, Aviation, Textile, Iron and Steel and disseminate the data to operating staff for informed decision making. Specific studies on Companies/ Groups as directed by the Bank’s Board may also conducted.
3. The Bank shall take steps to adopt “Internal Ratings Based Approach” for Credit Risk. For this purpose, policies and governance structure related to credit risk management shall be approved by the Risk Management Committee of the Board. The governance structure shall be robust for effective implementation of internal rating.
4. Models for estimation of Probability of Default, Loss Given Default and Exposure at Default have to be developed, to calculate expected default.
5. Bank shall regularly conduct, stress test on its Credit portfolio and Stress Scenarios shall be regularly updated in line with industry best practices and changes in macro-economic variables.
6. Regular meetings of Credit Risk Management Committee and meetings of Risk Management Committee of Board shall be conducted to review various risk policies, industry status and exposure norms.
B. Market Risk Management:
1. Market Risk is the possibility of loss that a Bank may suffer on account of changes in values of its trading portfolio due to change in market variables such as exchange rates, interest rates, equity price, etc. The Market Risk management process involve identification of risks, and measurement of risks, control measures, monitoring and reporting systems.
2. The Bank shall have Board approved policies pertaining to the risks for trading in Foreign Exchange, Derivatives, Fixed Income securities, Equities and Mutual Fund. Market risks are controlled through various risk limits such as Net Overnight Open Position and Daylight Position of Foreign Currency, Modified Duration, Stop Loss, Concentration & Exposure Limits etc.
3. Presently, most banks compute market risk capital under Standardized Measurement Method. The Banks have to migrate to advanced approach under Basel-II for market risk viz. Internal Models Approach. It is a value at Risk (VaR) based tool for monitoring of Bank’s trading portfolio. The VaR methodology shall be supplemented by conducting stress test of the trading portfolio at quarterly intervals.
4. The Market Risk shall be monitored and reviewed by the Market Risk Management Committee and the Risk Management Committee of the Board.
C. Operational Risk Management:
1. Operational Risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.
2. The main objectives of the Banks Operational Risk Management are to continuously review systems and control mechanisms, create awareness of operational risk throughout the Bank, assign risk ownership, align risk management activities with business strategy and ensure compliance with regulatory requirements, which are the key elements of the Operational Risk Management.
3. Important policies, manuals and framework documents in line with RBI guidelines on Operational Risk Management Framework and Operational Risk Measurement System for migration to Advanced Measurement Approach should be in place.
4. The Board-level Operational Risk Management Committee, shall review the operational risk profile of the Bank at quarterly intervals and recommend suitable controls/mitigations measures for managing operational risk in the Bank.
5. There should be a committee on High Value Frauds, to periodically monitor and control high value frauds and also for mitigation of the same.
D. Group Risk Management:
1. Group Risk Management Committee shall put in place standardized risk management processes in Group entities. Here the group include both borrowers and lenders (Bank) and the entities connected with each one.
2. The Group Internal Capital Adequacy Assessment Process is to assess relevant risks and mitigation measures for capital assessment, in normal and stressed conditions. A Policy to ensure uniformity in assessment exercises of Group entities shall be in place.
3. A quarterly analysis of risk-based parameters for Credit Risk, Market Risk, Operational Risk, Liquidity Risk, Concentration Risk, and Contagion Risk is to be presented to Group Risk Management Committee/Risk Management Committee of the Board.
4. Exposure limits for Large Borrower, Capital Market Exposure as per RBI norms and also limits for unsecured exposures, real estate and intra-group exposures shall be set by the Bank.
Basel III Implementation:
Basel III Capital Regulations has come into force from April 1, 2013 and the process to be completed by March 2018. Bank has to put in place appropriate mechanism to comply with these guidelines.
E. Enterprise Risk Management:
1. For assessment of risks such as Liquidity Risk, Interest Rate Risk, Credit Concentration Risk, as well as adequacy of capital and overall risk management practices under normal and stressed conditions, bank shall have comprehensive internal capital adequacy assessment process in place.
2. As part of the Risk Management the Bank has to transform its role into a strategic function aligned with business objectives, in order to adopt Enterprise Risk Management (ERM) framework.
3. Global practices like Risk Appetite, Risk Aggregation and Risk based Performance Management System including Economic Capital and Risk Adjusted Return on Capital shall also be covered within the ERM project.
Information Security:
1. Bank shall implement a robust IT policy and information system security policy in line with the international best practices. The policy shall be reviewed periodically and suitably strengthened in order to address emerging threats. Control objectives for information and related technology (COBIT) of U.S.A. and the Information technology infrastructure Library (ITIL) of U.K. have contributed substantially in this regard which the banks can take advantage of.
2. Regular security drills and employee awareness programs shall be conducted to ensure security and increased awareness among staff. Business Continuity Management Systems has to be implemented.
Internal Controls:
The bank has to have inbuilt internal control systems with well-defined responsibilities at each level to conduct internal audit through its Audit Department. Audit Committee of the Board shall exercise supervision and control over the functioning of the audit department. The inspection system plays an important and critical role in identification, control and management of risks through the internal audit function which is regarded as one of the most important components of Corporate Governance.
The Bank shall have two streams of audits – Risk Focused Internal Audit and Management Audit covering different facets of Internal Audit requirement. All accounting units of the Bank shall be subjected to risk focused audit. Management Audit covers administrative offices and examines policies and procedures besides quality of execution thereof.
Besides the above, the department shall conduct Credit Audit, Information Systems Audit, audit of foreign offices, if any, and Expenditure Audit and oversee the policy and implementation of Concurrent Audit and Other Internal Audit. In addition the level of rectification of irregularities by branches and audit compliance at select branches is also to be undertaken.
Risk Focused Internal Audit:
The bank shall undertake a critical review of the working of audit department in the context of risk focused audit as an adjunct to risk based supervision as suggested by RBI.
Management Audit:
With the introduction of Risk Focused Audit, Management Audit may be reoriented to focus on the effectiveness of risk management processes and the procedures followed in the Bank.
Credit Audit:
Credit audit aims at achieving continuous improvement in the quality of Credit portfolio of the Bank by critically examining individual large loans and large exposures. Credit Audit System shall provide feedback to the business unit by way of warning signals about the quality of advance portfolio and suggest remedial measures. Credit Audit shall carry out a review of all the pre-sanction and sanction process of all large advances within 6 months of sanction / enhancement / renewal.
Information System Audit:
All the branches should be subjected to Information System Audit to assess the IT related risks as part of Risk Focused Audit of the branch. Audit of centralized IT establishments should also be carried out by a team of qualified officials.
Concurrent Audit System:
Concurrent Audit System is essentially a control process integral to the establishment of sound internal accounting functions, effective controls and overseeing of operations on continuous basis. Concurrent Audit System shall be reviewed on an on-going basis as per the RBI directives so as to cover Bank’s Advances and other risk exposures as prescribed by RBI and shall prescribe the processes, guidelines and formats for the conduct of concurrent audit at branches.
Improvement in Work Culture:
All necessary steps shall be taken, to motivate the staff, improve work culture and work ethics.
Essay # 5. NPA (Non Performing Assets) Management in Banks:
Indian banking system generally suffers from increase in non-performing assets year by year.
While a major reason for such high Non Performing Assets (NPA) could be the overall slowdown in economic growth and other macro-economic factors, there is an urgent need for effective implementation of credit policy and practices to achieve the following objectives:
(a) Analyse and address the reasons for relatively higher NPAs in comparison with better performing banks.
(b) Reasons for relatively low share in better performing business segments.
The structure described above will facilitate the bank to respond to the business opportunities quickly and at the same time have adequate control and oversight. Committees shall have periodic meeting and special meetings whenever there are enough proposals to be considered. The collective decision making process has proved to be better in risk assessment and quality decision making.
The Bank shall fine tune its policy on Corporates. Corporate loan has twin advantages as it is extended for long term working capital requirements of the corporate and requires only a minimum Fixed Assets Coverage Ratio. Similarly, the pricing and terms of various other loans like Home Loans, etc. have to be adjusted to generate high growth with good quality.
The bank shall try to achieve 100% ECGC cover for all export oriented units to reduce the risk. In all other cases the bank shall try to get insurance, cover wherever available for all export oriented credit and domestic credit to reduce the risk. Credit Insurance cover may be costly in which case it has to be selective.
The bank shall employ multi-pronged strategies to resolve stressed assets (NPA) such as:
1. Restructuring of both Standard assets and NPAs, either though the Corporate Debt Restructuring mechanism or through a bilateral arrangement.
2. Recovery through auction of assets.
3. Filing cases with debt recovery tribunals or other Courts for recovery of dues.
4. Identifying strategic investors and explore for takeover of stressed assets by them.
5. Sale of NPAs to Asset Reconstruction Companies.
6. Entering into One Time Settlements with borrowers.
7. Using Recovery Agents to take possession of properties mortgaged to be Bank and arranging for their auction
8. Using the e-auction platform to reach out to as many prospective bidders as possible.
9. Debt Asset swaps can be considered in suitable cases.
10. Engaging investigation agencies to trace out unencumbered assets of promoters and guarantors and obtaining attachment before judgments over these properties
11. Identifying companies and promoters who are willful Defaulters and arranging for display of their names on the websites of Credit Information Companies such as CIBIL. These names are also reported to the Reserve Bank of India. This is only a deterrent measure but likely to produce favourable impact on loan recovery.
Essay # 6. Risk Focused Audit in Banks:
The Reserve Bank of India has issued comprehensive guidelines to all banks on credit risk, market risk and operational risk. It further advised them to redesign their internal audit to focus on risk management, so as to facilitate risk based supervision by R.B.I.
Risk Focused Audit:
Accordingly the internal audit function is redefined.
Besides rectifying the transaction defects it should focus on:
(1) Risk management policy
(2) The level of understanding of the policy by the operating staff and its implementation
(3) Internal control system
(4) Reporting system
(5) Data governance its reliability and accuracy
(6) Regulatory compliance
(7) Disaster recovery plan.
The internal audit should deal with operational risks besides credit and market risks. It is important because, many banks suffered badly due to poor internal control. The internal control systems take care of transaction testing, checking accuracy and reliability of accounting records.
In addition to checking the integrity of control reports and checking regulatory compliance, the risk focused audit should judge the effectiveness of risk management, adequacy of internal control system, ability of the bank to identify analyse and manage risk and control the key process.
In other words internal control system will hereafter be more importantly risk focused. The new area of concern will be operational risk which is of a wide range in nature. Most of them arise out of human and technological failures. The internal audit system should not only identify the risk, quantify it based on certain standard procedure and also suggest measures to mitigate the risk.
Risk Focused Supervision:
It is the intention of the Reserve Bank to adopt risk based supervision of banks and compile risk profile of individual banks.
The risk assessment areas identified by them are:
(1) Capital adequacy
(2) Credit risk
(3) Liquidity risk
(4) Market risk
(5) Operational risk
(6) Business strategies and environment
(7) Revenue and profit
(8) Group risk
(9) Internal control risk
(10) Management risk
(11) Compliance risk
(12) Organization risk
A comprehensive risk assessment would be made in order to arrive at the overall risk profile of the bank. RBI has circulated the risk profile models to enable banks to do self-appraisal.
R.B.I, would also prepare the risk profile of banks and based on which they may finalise inspection and supervision programme. This will particularly enable R.B.I, to decide on the intensity of supervision. In respect of banks with high risk profile, it will spur the individual banks to identify the areas of concern and take necessary corrective measures.
It is not the intention of R.B.I, to replace the traditional transaction based audit by risk focused audit. It would be an additional tool in implementing Basel II norms. The new approach is to judge the performance of banks in risk management area.
Risk based supervision will rely more on offsite inspection and the regular audit under camels (capital adequacy, asset quality, management, earnings, liquidity and system) and less on onsite inspection. Even during onsite inspection, Reserve Bank would depend more on risk focused audit of the bank. Therefore the responsibility lies on the banks to establish that their risk focused audit is sound and off site data are reliable.
Essay # 7. Coverage and Approach in Banks:
Risk focused audit should cover all risks faced by the banks and should recognize all internal and external factors that contribute to risk.
A. The internal factors consist of:
(i) Complexity of structure
(ii) Nature of activities,
(iii) Quality of personnel
(iv) Organizational changes.
B. External factors consist of:
(i) Economic conditions,
(ii) Change in the industries sector and
(iii) Technological advancement.
The audit should cover individual business across all activities. Audit should enable decisions on mitigating controllable risks and in case of uncontrollable risks it should enable action either to reduce or exit altogether.
It would also look into the following areas:
(i) Access procedure for officials to tangible assets like cash and securities through holding limitation, dual custody, periodic inventory verification etc.
(ii) Exposure limits.
(iii) Verification and reconciliation of approvals and authorizations and comment on them.
Audit should verify whether conflicting duties are allotted to one person and if so the consequences thereof. It should also cover the application and effectiveness of risk management procedure, the risk assessment system particularly the way in which risk is identified, analysed prioritized and managed.
It would also suggest solution for current risks and anticipated future risks. Generally the bank business consist of different type of deposit accounts and loan accounts. Parameter for risk evaluation of each activity under deposit and loan portfolios has to be defined. The risk level for each may be ranked as high, medium, low or nil.
Further it would comment on the trend in risk level based on random selection of accounts and the appraisal and conduct of accounts and also comment on default record, i.e. increase or decrease in quantum of Non-Performing Assets (N.P.A.). Audit should indicate the exposure in each industry/trade and indicate whether they are in conformity with internal and external guidelines.
On operational risk the auditor should assign the rank for each item of risk on numerical basis and also judge the risk mitigation capacity and if that is poor negative score may be given.
Finally the report may also indicate overall rating and change in risk profile compared to previous year. Rectification of errors of previous report should be specially commented upon.